In New Energy Era, Gushers of Opportunity

It isn’t too late to learn important lessons from the surprising resurgence of American oil and gas. It is also not too late to profit from it.

The surge in energy production has confounded giant oil companies, created billionaires who are emerging as the nation’s new Rockefellers and Gettys, and altered America’s economic and geopolitical outlook.

Just a few years ago, the country seemed destined to rely on imported energy. Today, the U.S. is moving toward energy independence.

The dramatic shift is thanks to a few stubborn Americans who developed improved—and controversial—methods to hydraulically fracture, or frack, shale and other tough rock. They also introduced ways to drill horizontally in challenging, compressed rock.

Pioneers of the new age of energy have scored historic fortunes and rewarded their shareholders, while also creating an environmental backlash.

They’re not yet household names, however. Harold Hamm grew up dirt-poor in a tiny town in Oklahoma. He began school each year around Christmastime because he had to help his parents pick cotton until it became too cold to be in the fields. Today, Mr. Hamm, founder of Continental Resources, is worth more than $14 billion. His stock is up over 50% in the past year.

Mark Papa, who helped turn EOG Resources into an oil power with huge discoveries in Texas, has seen EOG’s shares jump more than 40% in the past year.

Charif Souki, an immigrant from Lebanon, runs Cheniere Energy, which is expected to be the first company in the lower 48 states to export natural gas. The stock has climbed 152% in the past year and he’s worth $350 million.

A key lesson from the era: Smaller companies often are best at engineering breakthroughs.

The rise of EOG Resources, which today is worth $46 billion—or more than Hershey, Alcoa and Southwest Airlines combined—illustrates the point. In October 2007, EOG was a midsize company discovering growing volumes of gas. EOG’s executives were celebrating their success.

But it dawned on Mr. Papa, EOG’s chief executive at the time, that rivals also might be able to produce more gas from American shale formations. Soon, Mr. Papa was gripped by fear. He was sure natural-gas prices would tumble as a glut developed.

EOG launched a clandestine effort to lease acreage in the Eagle Ford Shale formation in Texas, an oil-soaked field that eventually would play a major role in moving the nation toward energy independence.

In similar fashion, Mr. Souki’s company, Cheniere, obtained approvals to export gas from the U.S. well before oil giants realized the country might have enough excess supplies to justify sending some abroad.

The oil behemoths often are safer bets in tough times, thanks to their strong balance sheets and stable customer bases. But they can find it harder to anticipate future trends.

Chevron disbanded an innovative shale-drilling unit in the 1990s, allowing the energy upstarts to emerge. The move was similar to how Microsoft in 2000 built a rudimentary system to marry Web search with advertising but shut it down, enabling Google to make billions. Recently, Merck and other large pharmaceuticals have seen research-and-development lag compared with smaller rivals.

It is a reminder that investors should maintain an allocation to small-cap stocks, which are up 32% so far this year based on the Russell 2000 index. As for energy, some say the nation’s revolution is just getting going and that the best investments remain smaller and midsize companies.

“We’ve drilled 10% of the nation’s shale wells, so [we] have 20 years of unconventional resources,” says Dan Pickering, co-president and chief investment officer of TPH Asset Management in Houston. “It isn’t too late to be involved…but it’s not a story about the majors like Exxon, Chevron and BP—they have exposure but” are unlikely to hit home runs in the fields like smaller competitors.

Oil Versus Gas

Analysts say the best gains could come from aggressive midsize companies focused on oil rather than natural gas.

American natural-gas prices, determined by supply and demand in the U.S., have fallen about 72% since their recent peak in 2008, and drillers are becoming more efficient, or are doing more with fewer drilling rigs, across American shale formations, notes Citigroup. That could keep a lid on natural-gas prices.

But oil is a global market. While growing U.S. crude supplies could keep a lid on current prices—about $94 a barrel—that’s high enough to bring sizable profits to a range of midsize companies. Last week, Devon Energy spent $6 billion to buy oil acreage in the Eagle Ford area in Texas, underscoring the trend.

Some of the most exciting companies are also the most dangerous stocks, though. Pioneer Natural Resources is up about 75% in the past year but now trades at expensive levels based on earnings and cash flow. Nonetheless, the stock, which has fallen over the past month amid some profit-taking, is a top pick of Citigroup.

Mr. Pickering is a fan of Pioneer, Concho Resources and Diamondback Energy. They are finding more oil in Texas’ Permian Basin.

“Those companies are sitting on huge, multiple oil reservoirs that have been exploited vertically in the past and just now are being exploited horizontally,” he says.

Shares of many of the pioneers in the energy era, such as EOG and Continental, now are expensive, analysts say, but still have upside.

Credit Suisse advises investors to look broadly for ways to wager on the U.S. energy revolution. As natural-gas prices stay low, a range of companies will benefit from lower costs, including chemical companies such as Agrium and LyondellBasell Industries.

The bank also recommends Halliburton, which provides fracking services, and says EOG and Marathon Oil are “low-cost ways to play the Eagle Ford Shale,” one of the nation’s hottest oil formations.

“We are still in the early innings for U.S. shale,” the firm said in a recent report, adding that U.S. companies will see profit margins expand and the country will see trade deficits shrink.